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Tuesday, October 28, 2014

Secular Stagnation and the Limits to Growth

You have heard the term “secular stagnation” recently in regards to the economy. This is a major point of discussion among economists right now, and since long-term trends in economics is one of the things we do here, it makes sense to pay attention to it.

Matt Yglesias has written a good article at Vox explaining the basics.

For starters, it has nothing to do with secular versus religious. Instead, the term comes to us from a 1939 presentation given by Alvin Hansen titled "Economic Progress and Declining Population Growth." In these tailing days of the Great Depression, Hansen was trying to draw a contrast between a cyclical period of slow growth and a structural transformation of the economy. Hansen believed that the world was not experiencing a down period during an up-and-down series of fluctuations. Instead, he said, "we are passing, so to speak, over a divide which separates the great era of growth and expansion of the nineteenth century" from a new era of much slower growth.

The Depression, in other words, was not a passing phenomenon but rather something that might last indefinitely. Instead what happened is that Nazi Germany launched a war that ended up intersecting with an already-ongoing military conflict between Japan and China. This battle lasted for years and involved nearly the entire planet. During its course, global output surged — though production was mostly dedicated to killing people and blowing things up rather than increasing living standards. But after the war, the economies of Western Europe and North America boomed. Secular stagnation was largely forgotten. But with growth consistently disappointing in recent years, interest in Hansen's ideas has rebounded.

Importantly, although the rapid return of growth led to a collapse of interest in the secular stagnation hypothesis it didn't exactly debunk it. Hansen's argument was that the American economy lacked the kind of self-correcting forces that would restore an adequate level of demand and end the Depression. The outbreak of a giant world war is definitely not the same thing as an economy self-correcting — it was an enormous external source of stimulus.

...the hypothesis was that there was a fundamental excess of desired savings over desired investment, and that this would require government intervention on a sustained basis to achieve full employment.

This ideas and terminology from Albert Hansen were resurrected when economic high priest Larry Summers began using it to explain what he thought was wrong with the economy. Secular stagnation is not a realization of the fact of lower growth, it is a theory as to the cause of lower growth. It argues that the problem is not with supply, but inadequate demand, and that restoring this demand requires a stimulus. In the Great Depression, World War 2 provided the necessary stimulus. Here’s Paul Krugman:

To the extent that secular stagnation is an important and perhaps shocking concept, it really has to be distinguished from the proposition that potential growth is slowing down.

What I wrote:

For those new to or confused by the term, secular stagnation is the claim that underlying changes in the economy, such as slowing growth in the working-age population, have made episodes like the past five years in Europe and the US, and the last 20 years in Japan, likely to happen often. That is, we will often find ourselves facing persistent shortfalls of demand, which can’t be overcome even with near-zero interest rates.

Secular stagnation is not the same thing as the argument, associated in particular with Bob Gordon (who’s also in the book), that the growth of economic potential is slowing, although slowing potential might contribute to secular stagnation by reducing investment demand. It’s a demand-side, not a supply-side concept. And it has some seriously unconventional implications for policy.

This is a really important distinction, because secular stagnation and a supply-side growth slowdown have completely different policy implications. In fact, in some ways the morals are almost opposite.

If labor force growth and productivity growth are falling, the indicated response is (a) see if there are ways to increase efficiency and (b) if there aren’t, live within your reduced means. A growth slowdown from the supply side is, roughly speaking, a reason to look favorably on structural reform and austerity.

But if we have a persistent shortfall in demand, what we need is measures to boost spending — higher inflation, maybe sustained spending on public works (and less concern about debt because interest rates will be low for a long time).

Krugman mentions other theories of stagnation, such as those of Robert Gordon who we’ve covered extensively in the past. Yglesias fills in some details:

The most prominent alternative to secular stagnation is probably the technological slowdown hypothesis. This view, best represented in academia by Northwestern University economist Robert Gordon, in the business world by investor Peter Thiel, and in the popular press by Tyler Cowen, posits that slow growth is a structural phenomenon due primarily to a slowdown in the rate of technological progress. Cowen's book the Great Stagnation is a good treatment of these ideas.

Another idea you sometimes hear about is the Limits to Growth hypothesis which dates back to a 1972 book by Donella Meadows, Dennis Meadows, Jørgen Randers, and William W. Behrens. This is the view that there are fundamental ecological limits to the expansion of human economic activity, and that only a slowdown or cessation of growth can make continued human existence sustainable.

These ideas distinguish themselves from secular stagnation in that they are primarily ideas about the supply side of the economy. In other words, they say the economy is growing slowly because we are running out of new inventions or natural resources. The secular stagnation hypothesis, by contrast, is the view that the economy can no longer be trusted to maintain an adequate level of demand. One way to dramatize the difference is to specifically focus on unemployment. The technological slowdown hypothesis is primarily the belief that we won't get much richer over the next few years, even if people do manage to get jobs. The secular stagnation hypothesis is the opposite view — the view that we may get a bunch of shiny new gadgets, but unemployment will stay high.

The mention of the Limits to Growth study is good, but it does not really acknowledge the problems of Peak Oil – the idea that we’ve reached limits because we’ve maxed out the return on investment of crucial energy supplies, and thus will be economically constrained. My guess is that, since LTG was mentioned, the lack of Peak Oil theory comes from a lack of knowledge rather than a deliberate attempt to ignore it. It’s a sad sign of the ignorance of these ideas of the punditocracy.

Fortunately, Nate Hagens has given an excellent speech summarizing the ideas and ramifications of Peak Oil (long, but well worth watching in full). Someone might want to email this to Yglesias (as if he would watch it):

Also missing is the Marxist theory of the tendency of the rate of profit to fall. I don’t know much about this theory, so I don’t know if this is a valid cause or not.

There’s another reason there is inadequate demand – inequality. The middle class is being gutted and doesn’t have the money to afford what the economy produces, while the rich have so much money that they have nothing to do with it but watch it pile up. It reminds me of the manure theory of the money – if it piles up it stinks and festers, but if you spread it around it helps things grow:

Secular Stagnation and Wealth Inequality, by Atif Mian and Amir Sufi: Alvin Hansen introduced the notion of “secular stagnation” in the 1930s. Hansen’s hypothesis has been brought back to life by Larry Summers...

A brief summary of the hypothesis goes something like this: A normally functioning economy would lower interest rates in the face of low current demand for goods and services... A lower interest rate helps boost demand.

But what if ... real interest rates need to be very negative to boost demand, but prevailing interest rates are around zero, then we will have too much savings in risk-free assets — what Paul Krugman has called the liquidity trap. In such a situation, the economy becomes demand-constrained.

The liquidity trap helps explain why recessions can be so severe. But the Summers argument goes further. He is arguing that we may be stuck in a long-run equilibrium where real interest rates need to be negative to generate adequate demand. Without negative real interest rates, we are doomed to economic stagnation. ...

In our view, what is missing from the secular stagnation story is the crucial role of the highly unequal wealth distribution. Who exactly is saving too much? It certainly isn’t the bottom 80% of the wealth distribution! We have already shown that the bottom 80% of the wealth distribution holds almost no financial assets.

Further, when the wealthy save in the financial system, some of that saving ends up in the hands of lower wealth households when they get a mortgage or auto loan. But when lower wealth households get financing, it is almost always done through debt contracts. This introduces some potential problems. Debt fuels asset booms when the economy is expanding, and debt contracts force the borrower to bear the losses of a decline in economic activity. Both of these features of debt have important implications for the secular stagnation hypothesis. We will continue on this theme in future posts.

I wonder if the key is “secular,” as in sector, as in sectoral misallocation. Many observers of the US economy have worried about the impact of financialization—the relative growth of the finance sector—on growth. Part of the concern is the bubble machine, and part is the devotion of considerable resources to non-productive activities.

And the misallocation is profound. Who out there thinks financial markets are playing their necessary role of allocating excess savings to their most productive uses? Anyone?

And what does mainstream economics recommend. Mainly low interest rates. But what if low interest rates do nothing more than inflate bubbles?

Summers ... thinks low rate policies contributed to full employment in the mid-aughts and late-'90s only by encouraging speculative bubbles in first the stock market and then the housing market. For Summers, the question is not what's happened for the past five years but rather "can we identify any sustained stretch during which the economy grew satisfactorily with conditions that were financially sustainable" in the last 15 years. In this view, government spending — especially on infrastructure — is the only real cure.

Wikipedia also has some information on the possible causes of economic stagnation:

I think this explains the skepticism on the part of peak oil people for both the actions of the Federal Reserve and government-funded economic stimulus. Economists typically assume the problem is demand, whereas Peak Oil and Limits to Growth believes the problem is supply, that is, growth is no longer possible nor desirable. As Krugman himself points out, if you believe that is the case then your proescriptions are totally different – “If labor force growth and productivity growth are falling, the indicated response is (a) see if there are ways to increase efficiency and (b) if there aren’t, live within your reduced means. A growth slowdown from the supply side is, roughly speaking, a reason to look favorably on structural reform and austerity.”

And I think this is why so many Peak Oil people favor of policies that restrict growth and shrink the economy.

I would argue that this also fits in with a degrowth agenda. Not pointed out above is the argument which I’ve made extensively that there are diminishing returns inherent to growth and technological progress. That is, each unit of growth and each new electronic doodad gives us less and less benefit at the margin, while producing more downsides in terms of pollution, stress levels, etc.. However, if we pursue lower growth as a policy, then we also need to think about distribution. William Galton writes:

Unforeseen developments may have a similarly transformative effect in the decades to come. But we cannot rule out the possibility that the current woes of the developed economies reflect long-term structural changes. Because growth is so central to healthy societies and healthy politics, we should do everything possible to ward off stagnation—including adopting policies that would have been unthinkable when the magic of the market was regarded as the sure cure for our ills.

For me, those “unthinkable” things would be Modern Monetary Theory - the idea that the government is not “revenue constrained,” but can spend directly to build public transportation, micro-housing for the homeless, solar panels, rebuild crumbling infrastructure, and so forth. It would include be a shorter work week. It would include revitalizing local economies to able to provide for people rather than a global economy of exports and workers competing against the cheapest labor anywhere in the world. And it would certainly include putting restrictions on the predation of the working classes. Too bad none of these things are possible as long as plutocrats control our politicians and media outlets.

If we don’t do anything, as Thomas Piketty has argued, the rate of return on investments will exceed the growth rate of the economy and the wealth of the already wealthy ill increase without bound. This will lead to “patrimonial capitalism” in his phrase, or as I’ve argued, a Neofeudal social order.

We’ve seen how this works out in practice – soaring levels of debt, low-wage scut jobs, crumbling cities full of homeless people and drug addicts, declining education rates, the rich in gated communities, and a lack of public services including even a loss of first world services like running water. Some facts:

2 comments:

Very interesting post. There is not much available on the connection between what we are seeing today in the economy, and the limits to growth. Very few economists factor in our finite resources, and so it seems that they have a term for what our economy is experiencing (secular stagnation), but don't connect any dots to the limits to growth.

I encourage you to write more on these connections, perhaps a continuation of what a collapse looks like. I like your writing and awareness.

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